UNCTAD: Main Findings on Local Content Requirements in the Oil and Gas Sector

Introduction

There is a formidable body of literature devoted to economic theorizing on the efficacy of local content requirements (LCRs) policies generally, and in developing countries specifically. Notably, there is perhaps an even more formidable body of empirical studies examining the operations of LCRs in the oil and gas sector over the past four decades. I have already devoted two columns to some aspects of this literature, seeking to draw lessons that Guyana can learn from it as she prepares for the operationalization of the oil and gas sector, post- 2020. This is the reason why I had indicated last week that, today’s and next week’s column, will be devoted to considering the main findings of the two studies: United Nations Conference on Trade and Development (UNCTAD) and the World Bank, which I have referenced before.

UNCTAD Study

My choice of the 2013 UNCTAD report, prepared by Sacha Silva of World Trade Advisers is based on two features, apart from its excellence. One is that UNCTAD has pointedly indicated it has “substantially edited” the report before its release. And, by so doing, it lends its substantial authority to the document. Second, the study explicitly focuses on LCRs aimed at sustainable development and green economy concerns. Indeed it notes that its introduction comes: “at a time when the green economy concept has moved from theory to practice, with a range of developed and developing countries placing local content at the heart of their green economy strategies and [in turn] their green economy plans at the heart of their industrial policies”. This fits comfortably with the Government of Guyana’s aspirations to develop a “Green State”.

Importantly also, the study observes that its timing reflects increasing emphasis in developing countries, on the sustainable element of traditional “development objectives”; such as rural and urban development; infrastructural planning, and industrialization.

For its part, the study has identified five main findings, which will be presented below. of income earned from producing goods and services by foreigners to local owners! Instead, the aim should be to locate LCRs in a wider strategy focused on capacity-building of firms and domestic value added for the broader economy.

While local ownership clearly remains desireable over the long-term, from a strict economic efficiency standpoint, LCRs should be synonymous with capacity-building because this focuses more on managerial, technical, and skills-endowment within businesses, and not merely ownership.

Such a view, I believe, does not conflict with the long-term goal of indigenizing ownership and control of strategic sectors. The emphasis on competitiveness capacity building and domestic valueadded as guides to designing and implementing LCRs, is essentially a short-tomedium term goal leading into the longer-term goal.

The second main finding of the study is the central importance that should be placed on openness, transparency and accountability, in the design of the institutional framework for LCRs. As the study aptly states: “LCRs must be formulated in an inclusive and transparent manner [as experiences reveal stakeholders very often view LCRs] as operating too narrowly and selectively”. That is, in a manner to favour supporters of those in authority.

The above circumstances have led the study to urge that LCRs should be administered by institutions of high standing and ensuring thereby a level playing-field for all domestically located firms. Of course these institutions need to be adequately resourced.

The third finding stresses the fundamental importance of realism in designing LCRs and prioritizing “soft targets”. Thus, it is argued, LCRs should be based on plausible and not “hyped-up expectations”. In other words the temptation should be avoided of setting “over ambitious and pie-in-the-sky” expectations, which cannot be met.

The fourth main finding is that LCRs (similar to policy guidance offered for other forms of “protection”), should be “calibrated”, and therefore, implemented orderly over time.

And, ideally also, they should be reduced/phased out in an orderly manner over time. Indeed it is further recommended that the latter should go hand over hand alongside the build-up of competitiveness capacity among the LCRs protected firms.

Clearly, the aim of this finding is to emphasize the fact that LCRs are, as we noted, second best solutions. Because of this reality, failure to specify the phase out of LCRs leads to the entrenchment of “special interests”, which thrive on regulatory barriers, subsidies, and tax expenditures.

Again experiences from a wide range of countries reveal that the initial gains from LCRs going to firms, are quite often dissipated, if these firms lose sight of the developmental aims behind the LCRs, and seek to maximize rents for themselves behind protective barriers. In such a process, competitiveness, cost/price efficiency, quality, and access, to these products invariably decline.

The last main finding of the UNCTAD study is: “LCRs should not be seen as a panacea to resolve systemic problems in the economy”. There is indeed one area of common purpose between government and the foreign firms controlling the production and export of oil and gas. That is, over the long-term, these firms, like the government itself, have a commercial interest in increasing local content, if this leads to reduced costs, removal of crossborder issues arising from importing, and opening-up the possibilities of local markets to the value chain of the oil and gas sector.

An abiding concern is that surveyed countries reveal: “the political class and its domestic lobby [portray LCRs] as a cure-all to attract foreign direct investment and generate jobs”. They are clearly not.

Conclusion

Next week I shall similarly summarize the World Bank’s main findings on LCRs in the oil and gas sector.